Brexit reality bites: The new dawn of trade friction
This week, as Brexit took effect, a company in Cork that sells sports posters to Europe and around the world ceased all direct online sales to the UK.
“There’s no point having the hassle,” said Wayne Mullins, a graphic designer who runs Kobe Designs. “I’ll just not send to the UK. I’ll keep selling to the [United] States and the rest of the world.”
The UK market accounts for 50% of Mullins’s sales. “It’s a significant part of the business, but it’s just not worth taking the risk for now,” he said.
Within days of a zero tariff, zero quota free trade post-Brexit agreement being struck, it appears that unforeseen, unheralded or just poorly understood frictions have come to the surface, hitting companies like Kobe Designs.
The EU-UK Trade and Cooperation Agreement (TCA) does away with customs duties, but VAT is proving to be one up-front headache.
It’s a complicated area.
The EU operates its own VAT area for the single market, even though each member state also has its own VAT rate.
If someone in Denmark buys a product from Ireland, the Irish VAT rate is charged by the Irish seller, but the Danish customer pays it to the Danish tax authorities.
This is not necessarily a loss to the Revenue Commissioners: the reverse is true for an Irish consumer buying a product from a Danish seller. Under EU rules, VAT revenue gets evened out across the single market.
However, this just applies to occasional, or one-off, sales.
If an Irish company is selling serious volumes into Denmark, say over €35,000 worth per year, the Irish company has to register for VAT purposes in Denmark. Once sales go over that €35,000 threshold, then the Danish VAT rate applies instead of the Irish one.
The idea behind this is that if an Irish company is only doing occasional online sales to customers in another member state, it does not have to go through the hassle of registering with that member state’s VAT system.
Before 1 January, when the UK was still in the transition period and subject to EU rules, if Wayne Mullins sold a football poster to a UK customer he did not have to register with the UK tax authorities for VAT purposes.
His customer would simply pay €20 for the poster, €5.75 for the VAT and €5 for shipping costs. Wayne would then pass the €5.75 worth of VAT on to his accountant, who in turn would pass it on to Irish Revenue.
“The problem is, now we don’t do it that way,” said Wayne. “We are unsure how it will pan out but it looks like you will need to register for VAT in the UK. We won’t know for another while yet.
“This is why I think it’s not worth the hassle in the short term until it becomes clear what we need to do. I do plan on selling in the UK again just when it’s clear and set in stone.”
What is now different?
Because the UK is no longer part of the EU’s VAT area, there are two new spanners in the works.
Firstly, the VAT threshold for the UK is gone. That means that any Irish company selling into the UK has to register with British Revenue for VAT purposes, even if those sales are only occasional.
There is a second complication.
Say if Wayne sells a set of eight premier league posters to a UK customer, the value would be €160.
Under UK rules, if the value of the consignment is over €150 (£135) then what is called “import VAT” applies, and it must be paid by the buyer at the UK post office when he or she picks up the posters.
With the UK out of the EU VAT area, and now a third country, it means the relatively straightforward model has changed both for the consumer and the seller.
“The VAT hits when the product reaches the port,” said Brian Keegan, director of public affairs at Chartered Accountants Ireland. “This is what’s causing the disruption. It’s not necessarily that there’s an additional VAT charge but it’s being handled differently.”
Within days of Brexit taking effect, scores of companies around the world announced they would not – in the short term – be doing business with UK clients, and vice versa, because of these new frictions.
Edward Heyward, author of Slaying Brexit Unicorns, compiled a preliminary list of 140 companies which had declared through their websites they had suspended trade.
Some were doing it because of the VAT complication, others because the UK was outside the EU’s food safety sphere. Gourmet Woodland Mushrooms ceased trading to the EU because exporting live mycelium – a fungus – required expensive EU Export Health Certificates which were beyond the resources of the company.
A Dutch firm selling bicycle parts – Dutch Bike Bits – also announced it would no longer sell to the UK because of the VAT complexity. The owner was inundated with abusive and outraged emails, presumably from Brexiteers, and sought help from Google Maps after numerous individuals gave the company a one star rating.
There were other unexpected shocks.
In the days leading up to the end of the transition period, representatives of the UK Food and Drink Federation (FDF) were stunned to learn during a conference call with DEFRA, the UK department of agriculture, that food products from one EU member state that went to a UK distribution hub and then back into the EU would lose their EU origin status and be subject to full EU tariffs when arriving at EU ports.
This would be particularly acute for Ireland. Historically, EU food producers have treated Ireland and the UK as one market to which tailored confectionery and other products would be sold, based on similar Irish and British taste and packaging preferences.
“A lot of the companies will have treated UK and Ireland as a single market in distribution terms,” said Paul McGrade, senior counsel with Lexington Communications, a consultancy. “If you think of the cultural closeness for a lot of food stuffs, we share a lot of those tastes. The chocolate in the shop as we know it looks different in Britain or Ireland than it does when you go into a shop in Brussels.”
With Britain as an EU member it made perfect sense for chocolate products from, say, the Netherlands, to be sent in bulk to a UK distribution warehouse and from there reboxed to service the Irish market.
But if the EU and UK have just struck a zero-tariff free trade deal, why should goods from one EU country (the Netherlands) be hit by a potentially crippling tariff when they arrive in another (Ireland) via a UK warehouse?
This is the reality of swapping a single market for a basic free trade agreement.
The single market facilitated highly integrated, just-in-time supply chains that ran between the continent, the UK and Ireland and back again.
Brexit shatters those supply chains, even if, under the new TCA, there are, on paper, no tariffs on food sold between the EU and UK.
It is a complex area.
If a UK firm buys a consignment of Irish mushrooms and turns them into a vegetarian lasagne, that product can still be sold back into Ireland tariff free.
That is because the TCA accepts “cumulation”, ie, the ability for a company to count as British components that are sourced in the EU (and vice versa), so long as there is an acceptable level of processing involved.
The problem with the chocolate product coming from the Netherlands to a distribution hub is that there is no processing involved. The products are simply re-packaged and spun off again into the EU (Ireland).
One industry source said that the product becomes like a “stateless” person.
“The rules of origin are key to international trade,” said Maree Gallagher, who specialises in food law with the law firm Covington & Burling. “Where does something originate? The way you determine the origin of a product is where the last substantial process happened.”
If cheese is brought in from France and then processed as a pizza topping in the UK the pizza (cheese and all) remains a UK-origin product, thus benefiting from preferential zero-tariff access back to the EU.
But for much of the food in question, there is no processing involved.
Prior to Brexit, the UK’s membership of the single market meant that large volumes of food could be brought in seamlessly from the continent, then stored in a warehouse so that multiples like Tesco and M&S could source cheese or other products at short notice.
“If you’re sending cheese to Donnybrook Fair or Supervalu and if it’s loaded on a truck in Paris and ends up in Dublin that’s absolutely fine,” said Maree Gallagher. “But if you’re stopping off in the UK and unpacking it and repacking it, and keeping it in a distribution warehouse as part of the just -in-time delivery then it’s different.”
Similarly, if Tesco brings 100 boxes of wine in from Spain then separates one box out to be sent to Ireland the wine no longer benefits from tariff-free access.
It’s understood that the UK sought flexibilities on this during the negotiations but was rebuffed by the European Commission.
The Commission’s view, according to several sources, is that Brexit means existing distribution networks and supply chains are now defunct and will have to be replaced by other systems.
One would be to use the transit convention, whereby goods are shipped direct from the continent in sealed containers, which remain sealed during the land bridge crossing, direct to Dublin, bypassing any warehouse reboxing.
Food shipped direct by ferry from France or Belgium would also face no formalities on arrival in Dublin.
Another option is that distribution hubs move out of Great Britain altogether and are relocated in the EU, either Ireland or another member state. But this will take time and capital, and in the meantime those food products in particular could be hit by punitive tariffs, giving rise to price hikes and empty shelves.
“You’re not going to sell your confectionery at the current price at a massive loss for three or four years while you build a distribution centre in Offaly,” said one industry source.
So far the Irish government has not spent any political capital on challenging the Commission’s insistence that these are the new rules and the Commission’s view that it does not make any sense to move goods out of the single market to a third country and back in again just because that was the way it has always been done.
A senior Dublin source said the government is “feeling its way” as these new realities bite before assessing how to respond. The source admits that many observers were simply blindsided by this particular aspect of the complex rules of origin issue.
Dublin accepts that Brexit has torn up the existing paradigm, but the source ruefully notes that Ireland’s geography, and the UK wedge between the island and the continent, cannot be ignored either.
It is early days, and there may be many Irish importers, EU exporters and UK distributors who will continue to operate as before in the hope that the authorities at ports take a pragmatic approach.
However, such an option is not sustainable long term. And because these complications will also apply to Northern Ireland, due to the Protocol, the fallout there will be laced with political toxins.
The DUP, desperate to recover the political initiative after hitching its wagon to a hard Brexit these past four years, will seek to capitalise on anything that puts the Protocol in a negative light.
In the weeks to come, the full impact of Brexit will become more and more apparent.
The free trade agreement just concluded suggests that the UK has retained the right to diverge from EU foods safety and animal health regulations, and the more London pursues that divergence the more existing food supply chains will be dismantled.
“That’s what falling back on third country terms means,” says Emily Rees, founder of Trade Strategies. “These are the choices you make. Either you want to have your own independent regulatory autonomy in these areas, or you decide you want to be aligned with the EU.”
The UK, or the current Conservative government at least, has made its choice.
Consumers and retailers on the island of Ireland, who either rejected Brexit or didn’t have a vote, will have to get used to the consequences.